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Bailout Bandits: The Biggest Borrowers From the U.S. Federal Reserve
The Eurozone debt crisis has replaced the U.S. financial crisis as the disaster du jour. But make no mistake: U.S. taxpayers will be paying the tab for the U.S. crisis for years.
That's evidently not true of the banking sector, however, whose massive financial-crisis windfall is just now coming to light.
In its January issue, Bloomberg Markets magazine reveals that – at the March 9, 2009 nadir of the financial crisis – the U.S. Federal Reserve had committed $7.77 trillion to rescuing the American financial system. That total was more than half the value of all that was produced in the U.S. economy for that entire year.
While this was going on however, it was a deep, dark secret. The Fed never let on, for instance, that American banks were in such deep trouble that they required a combined $1.2 trillion on Dec. 8, 2008 – "their neediest day," Bloomberg said.
But here's the best part: Many of the biggest banks have ended up doing great as a result of the central bank's largesse.
Here's why: Because these "emergency" Fed loans gave banks access to ultra-low (well-below-market) interest rates between August 2007 and April 2010, banks worldwide were able to earn an estimated $13 billion.
Dean Baker, co-director of the Center for Economic and Policy Research in Washington, told Bloomberg that banks seemed to have it both ways.
Banks "were either in bad shape or taking advantage of the Fed giving them a good deal," he said. "The former contradicts their public statements. The latter – getting loans at below-market rates during a financial crisis – is quite a gift."
Shah Gilani, a financial-crisis expert and Money Morning columnist who edits the free Wall Street Insights & Indictments newsletter, put it more simply: "The average American has no idea how protected the big banks in this country really are. Maybe that's because the biggest bank in the world is the U.S. Federal Reserve. And it happens to be a creation of – and 100% beholden to – the banks that it is a master shill for. It also lies to us and covers up Wall Street's misdeeds."
What follows is a "power ranking" of the 20 banks that saw their outstanding loans peak at more than $25 billion – and some insight on how this Fed lending enabled Wall Street to profit, even as Main Street suffered.
Why the U.S. Economy Will Be Weaker Than Expected in 2012
Anyone who hoped the U.S. economy would get back on track in 2011 was sorely disappointed.
The European sovereign debt crisis and the abysmal failure of policymakers to take effective action undermined any chance we had at a strong recovery.
And what's even worse is that we're in for more of the same in 2012. Indeed, the U.S. economy in 2012 will be even more sluggish than originally thought – and for the same reasons 2011 was a disappointment.
The Organization for Economic Cooperation and Development (OECD) estimates U.S. growth will slow to 2% next year, down from a 3.1% estimate in May. It forecasts growth will pickup to 2.5% in 2013.
Of course, these forecasts are contingent upon Congress finding a way to stimulate the economy and tighten fiscal policy – not an easy balance to achieve. Without such action, U.S. economic growth next year could be as slim as 0.3%, and only hit 1.3% in 2013.
Unfortunately, after a year of failing to reach a debt reduction agreement, there's little chance the government will rise to the occasion next year – especially when most representatives are focused more on reelection than they are resolution.
Furthermore, it's also doubtful that Europe's debt crisis will be contained enough to not severely disrupt the region's biggest nations and cause a credit crunch that ripples through the global economy.
That means another year of major risks.
"Uncertainty remains the watchword for the U.S. economy," said Money Morning Global Investing Strategist Martin Hutchinson. "The risks are still pretty high because no one's sure what the Europe outcome will be."
The likely outcome – U.S. economic growth will fall even lower.
Europe: The Biggest Unknown
The OECD earlier this week reported that Europe's weak monetary union is the main threat to the world economy. The group's 34 member nations, including the United States, will grow 1.9% this year 1.6% next, down from the May predictions of 2.3% and 2.8%.
"Contrary to what was expected earlier this year, the global economy is not out of the woods," Chief Economist Pier Carlo Padoan wrote in the OECD Economic Outlook.
China Returns to Growth Mode with Major Policy Shift
The damaging global economic effects that Europe's unfolding debt crisis pose have caused a sharp reversal in China's monetary policy – one that will lead to a greater expansion of the Red Dragon's economy.
The People's Bank of China announced yesterday (Wednesday) that it would lower the percentage of deposits commercial banks must hold in reserve by 50 basis points, effective Dec. 5.
This is China's first reserve requirement cut since 2008. It drops the level to 21% for large banks and 19% for smaller institutions.
The move was unexpected from the world's second-largest economy, which has been tightening its monetary policy for more than a year.
The change underscores the country's concern that exports, its main driver of economic growth, would weaken due to lower demand from the troubled Eurozone, China's biggest consumer. However, it's also a signal that after a year of tapping the brakes on growth to curb inflation, Beijing is ready to put its foot back on the accelerator.
"This is a clear signal that Beijing has decided that the balance of risks now lies with growth, rather than inflation," Stephen Green, greater China head of research at Standard Chartered, told The Financial Times. "This is a big move, it signals China is now in loosening mode."
China's gross domestic product (GDP) in the third quarter grew by 9.1% — the slowest pace in two years and down from 9.5% in the previous three months. That's the fourth consecutive quarter of declining GDP growth.
Loosening China's Monetary Policy
China fears its best customers, Europe and the United States, will keep reducing their imports as they're burdened with weak economies. Chinese exports in October rose by 15.9%, the smallest amount in two years.
"The weakness in exports was very much in line with the global environment, especially the slowdown in Europe, and that's going to continue through to the first quarter of next year," Li Cui, an economist with the Royal Bank of Scotland, told Reuters. "I think the underlying weakness is perhaps even weaker. [M]y estimation is that the real growth could only be around 7% to 8%, adjusting for export prices."
Why the Fed's Latest Rescue Effort is Doomed
World markets got a nice tailwind yesterday (Wednesday) on news that the U.S. Federal Reserve is stepping into the fray along with other central banks to boost liquidity and support the global economy.
Of course it's nice to see stocks get a hefty boost, but to be honest I'd rather see them rising on real news.
Not that this isn't a good development in terms of stock values – but come on, guys. When things are so bad that the Fed has to step into global markets and bail out the other bankers in the world who can't wipe their own noses, we have serious problems.
Think about it.
The Fed is going to collaborate with the European Central Bank (ECB), the Bank of England (BOE), the Bank of Japan, the Swiss National Bank and the Bank of Canada (BOC) to lower interest rates on dollar liquidity swaps to make it cheaper for banks around the world to trade in dollars as a means of providing liquidity in their markets.
Put another way, now our government is directly involved in saving somebody else's bacon at a time when, arguably, we don't have our own house in order.
The Fed is cutting the amount that it charges for international access to dollars effectively in half from 100 basis points to 50 basis points over a basic rate.
The central bank says the move is designed to "ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credits to households and businesses and so help foster economic activity."
Who writes this stuff?
Businesses are flush with more cash than they've had in years. The banks are, too. But the problem is still putting that cash in motion — just as it has been since this crisis began.
From Bad to Worse
I've have written about this many times in Money Morning. You can stimulate all you want with low rates, but if businesses cannot see a reason to spend money to turn a profit, they won't. And there's going to be little the government can do to encourage them to spend the estimated $2 trillion a Federal Reserve report estimates they're sitting on.
Similarly, if banks cannot see a reason to lend with reasonable security that loans will be repaid, they won't. And there's nothing the central bank can do about it, either. Neither low interest rates nor low-cost debt swaps will change the fact that companies and individuals are shedding debt as fast as they can despite the cost of borrowing being almost zero.
If anything, the Fed's newest harebrained scheme is going to make things worse. Absent profitable lending, many banks are already turning to bank fees and – like the airlines that are widely perceived to be nickel-and-diming passengers – this is understandably irking customers. Many are changing banks as a result, further fueling a negative feedback loop.
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Europe Headed for a 'Lehman Moment'
With credit drying up across Europe we may finally see the Eurozone experience its "Lehman moment" – a replay investment banking collapse that triggered the 2008 financial crisis.
Indeed, European banks are having a harder time getting money – part of the fallout from the Eurozone debt crisis – and the resulting credit crunch could freeze business activity, cause bank runs and plunge Europe into a deep recession that would badly damage the global economy.
"The Continent is headed towards deflation if there's not enough money circulating throughout their financing and banking systems," said Money Morning Capital Waves Strategist Shah Gilani. "This all becomes self-fulfilling at some point. It's a very dangerous situation, not just for Europe, but for the whole world."
A global financial crisis would derail the struggling U.S. recovery and pinch the profits of many multinational corporations.
Fresh data this week from the European Central Bank (ECB) showed the M3 Eurozone money supply actually shrank in October by 0.6%, its steepest drop since January 2009 – the height of the Lehman Brothers crisis.
A shrinking money supply is one of the early warning signals that credit availability is drying up, making it difficult or impossible for banks, businesses, and consumers to obtain loans.
"This is very worrying," Tim Congdon from International Monetary Research told The Telegraph. "What it shows is that the implosion of the banking system on the periphery is now outweighing any growth left in the core. We are seeing the destruction of money and it is a clear warning of serious trouble over the next six months."
Signs of capital draining from European banks abound.
The bank bond market is already frozen. European banks in the third quarter were only able to sell bonds worth 15% of what they sold in the same period in the previous two years, according to Citigroup Inc. (NYSE: C).
In the past six months, U.S. money market funds have withdrawn 42% of their money from European banks. And loans to French banks have fallen 69% since the end of May, according to Fitch Ratings.
Even retail customers have started to pull their money out.
"We are starting to witness signs that corporates are withdrawing deposits from banks in Spain, Italy, France and Belgium," an analyst at Citigroup wrote in a recent report. "This is a worrying development."
An Early Look at Things to Come
I made it back late Saturday night from my meetings in Germany.
While I was there, the German Central Bank (the Bundesbank) was unable to sell its full complement of bonds… for the first time ever.
That resulted in an immediate market dive in both Europe and the United States. Thus far, investors have regarded Germany as a "safe haven" and the Continent's strength amidst an ongoing debt crisis.
Now fears have emerged that even the strongest of the European economies has begun to feel the pressure.
This sets the stage for a shaky upcoming week of discussions about Spanish and Italian bailouts, the future of the euro, and the eroding power structure in Brussels.
The impact of the credit situation also took center stage during my meetings in Frankfurt.
The topic of my meetings centered on how to fund an expanding number of energy projects in Poland.
Not just any projects, remember, but the exploitation of major unconventional shale gas basins that could literally change the energy face of Europe.
Unconventional gas includes gas from shale deposits, coal bed methane, and tight gas (fuel reservoirs locked in impermeable, hard rock).
As I've said before, access to shale deposits has transformed the North American energy picture in less than five years. Now, Poland has committed to the rapid development of its own shale formations.
In fact, in September, Polish Prime Minister Donald Tusk interrupted one of my presentations to a government commission meeting in Krakow to make this policy announcement! Still, it is one thing to announce an intention and another to see it through.
The Challenge: Making It Happen
In this case, fields need to be identified and geological exploration must take place.
These stages are followed by seismic readings, test holes being spud, data collection and interpretation, pad construction, and well completion. And all this needs to happen before the gas even begins to flow.
At that point, an entire network of compressor stations, processing facilities, and pipelines need to be available for companies to bring the gas to market.
This will likely be the most expensive single infrastructure project ever attempted in Poland. Some of the technology and know-how is already there domestically. But most needs to be financed and imported.
Now some of the work is underway. A few international majors, such as Exxon Mobil Corp. (NYSE: XOM) and Chevron Corp. (NYSE: CVX), along with a range of middle- and smaller-sized U.S., U.K., Polish, and other European companies, are already taking stakes in what should be a high-risk and high-return undertaking.
But while the prospects look promising, this optimism is based on fewer than 10 test wells and very spotty geological data. Most of the heavy lifting will have to be done from the beginning. That means billions upon billions of euros (and dollars, and zlotys, and pound sterling) are required in investment.
And that's where my meetings this past week in Frankfurt come into the picture.
It's Time to Overhaul the Fed
The average American has no idea how protected the big banks in this country really are.
For the most part we don't even blink when we are lied to publicly by their CEOs.
Maybe that's because the biggest bank in the world, the U.S. Federal Reserve, which happens to be a creation of and 100% beholden to the banks that it is a master shill for, also lies to us and covers up Wall Street's misdeeds.
How else can you explain the Federal Reserve's practice of secretly feeding billions of dollars to big banks, and then looking the other way while those same banks lie to the public about their strength so they can raise desperately needed equity and borrow in the debt markets?
Why else would the Fed prop up Bear Stearns long enough for JPMorgan Chase & Co. (NYSE: JPM) to buy it, and then prop up JPMorgan? Why else would the Fed prop up Merrill Lynch for the benefit of Bank of America Corp. (NYSE: BAC), and then prop up Bank of America as Merrill dragged it down. And why else would the Fed prop up Wachovia just so it could be taken over by Wells Fargo & Co. (NYSE: WFC) – yet another bank that would come to need even more help?
Power and Ponzi Schemes
The pat answer from the Fed is that propping up failed banks long enough to be taken over by "healthy" institutions is better for the system than letting them fail. On the surface that's true, but it's what's under the surface that's destroying America's free market foundation.
Here's what's come as a result of the Fed's actions: The "Super-Six" – JPMorgan, Bank of America, Citigroup Inc. (NYSE: C), Wells Fargo, Goldman Sachs Group Inc. (NYSE: GS) and Morgan Stanley (NYSE: MS) – which held $6.8 trillion, or about half the industry's assets in 2006, had increased their holdings by 39% to $9.5 trillion as of September 2011.
So what's really going on is that the country's biggest banks, which weren't healthy when their CEOs lied to us (as they still do), have gotten even bigger.
With size comes power – the power to pay lobbyists, the power to pay for legislators, and the power to change regulations.
These banks don't always get what they want exactly when they want it, but they do eventually get what they need to make money hand over fist.
The whole thing reminds me of a Ponzi scheme.
The Federal Reserve might as well be Bernie Madoff and the banks "feeder funds" in this nationalized scheme to perpetuate the channeling of depositor money into banks and investor money into bank stocks and debt securities.
For the chain to be broken the Federal Reserve is going to have to be overhauled – seriously overhauled – and big banks are going to have to be broken up, once and for all.
Don't Wait Until January To Play the January Effect
A lot of investors have pocketed big gains from the so-called "January Effect." In fact, the January Effect – which refers to the historical tendency for stock prices in general, and small-caps in particular, to rise during the first month of the year – has better than an 80% success rate since the mid-1920s.
Of course, based on recent performance, the phenomenon may soon require a new name – and some new timing guidelines for traders hoping to profit from it.
The January Effect was first recognized in the 1940s, but its actual strength wasn't quantified until 1982 when Donald B. Keim, now a finance professor at the University of Pennsylvania's Wharton School of Business, presented research detailing the market's January performance superiority dating back to 1925.
Since then, studies by several other groups have verified Keim's results – both in terms of positive overall January performance and the extra strength of small-cap stocks. Some of the findings include:
- Stephen Ciccone and Ahmad Etebari, professors at the University of New Hampshire's Whittemore School of Business and Economics, reviewed stock market performance from 1926 to 2006 and found that January produced "the highest returns of any month of the year." Their study determined January posted positive returns 81.48% of the time, fueled by "outstanding small-firm performance."
- Research by The Wall Street Journal, reported in early 2010, found that from 1900 through 2009, the Dow Jones Industrial Average rose 62% of the time in January, while the Nasdaq Composite Index was up in 67% of the years studied, affirming the small-cap advantage.
- The Chicago Board Options Exchange (CBOE) found that from 1980 through 2006, small-cap stocks as measured by the Russell 2000 Index averaged a return of 2.5% in the month of January. That compared to respective January returns of just 1.7% and 1.6% for the Standard & Poor's 500 Index and the Dow.
- A 2003 study by Ibbotson Associates, now a part of Morningstar Inc. (Nasdaq: MORN), found that, from 1926 through 2002, the smallest 10% of U.S. stocks outperformed the largest 10% of U.S. stocks by an average of 9.35 percentage points during the month of January. That included both up and down years, though the broad market lost ground in January only seven times during that period.
All of that would seem to be a fairly strong endorsement for playing the January Effect – but there's one small problem: In recent years – most likely due to an increased awareness of the pattern and more traders trying to play it – the upward move in the market that typifies the January Effect has actually started in December.
In fact, since January 2000, the broad market (as measured by the S&P 500) has shown a decline from Jan. 1 to Jan. 31 on seven occasions – in 2001, 2002, 2003, 2005, 2008, 2009 and 2010.
However, if you move the beginning of the January Effect time period back to December and look for a top in mid-January, the success rate returns to near its historical norm, with only two years – 2002-2003 and 2005-2006 – showing broad market declines.
Small stocks, as measured by the Russell 2000 (which currently has a median capitalization of $473 million), also continued to outperform larger ones in all but two years – 2004-2005 and 2001-2002 (when the two indexes were virtually even). However, in a few years, like 2002-2003 and 2008-2009, the advantage came in the form of smaller losses.
The exact starting date of a December-January Effect move isn't precisely identified by the newer studies, but a quick glance at the numbers indicates the smartest approach may be "the-sooner-the-better":
Growth of Online Retailers Makes Internet the New Shopping Battleground
While online retailers have celebrated the growth of online shopping, conventional retailers determined not to lose customers have been ramping up their Internet efforts.
Forrester Research Inc. (NYSE: FORR) estimates that online shopping will increase by 15% to $59.5 billion this holiday season. And more Americans said they were planning to shop online yesterday, "Cyber Monday," this year – 122.9 million, according to a survey conducted by BIGresearch for Shop.org, up from 106.9 million in 2010.
Cyber Monday spending last year exceeded $1 billion for the first time.
"Last year [Cyber Monday] was the biggest day of the year, and as retailers know that, they compete," Mitch Spolan, senior vice president for national sales at LivingSocial, a daily deal Website that had set up offers with over a dozen retailers, told The New York Times. "It's a sport. We're expecting a record-breaking day."
In an environment of weak consumer spending, retailers of all kinds need to fight for every dollar.
This year online retailers encroached on Black Friday, the traditional day brick-and-mortar retailers launch the holiday shopping season, while conventional retailers returned the favor on Cyber Monday.
Black Friday online sales were up 26% over last year according to comScore, while the number of people visiting online retailing sites was up 35%. Meanwhile, foot traffic in stores was up 5.1% and overall retail sales were up 6.6%.
The robust turnout helped markets soar on Monday, with the Dow Jones Industrial Average climbing 291 points, or 2.59%, to close at 11,523.01.
"With brick-and-mortar retail also reporting strong gains on Black Friday, it's clear that the heavy promotional activity had a positive impact on both channels," comScore Chairman Gian Fulgoni told Reuters.
An Edge for Online Retailers
Nevertheless, Web-only retailers, led by the titanic Amazon.com Inc. (Nasdaq: AMZN), have experienced more growth and have several advantages over their conventional rivals, even though most, such as Target Corp. (NYSE: TGT), Wal-Mart Stores Inc. (NYSE: WMT), and J.C. Penney Company Inc. (NYSE: JCP) have embraced online retailing themselves.
The most significant advantage Web-only retailers have is the lack of overhead expenses to maintain large numbers of physical locations. Web-only retailers also don't collect state sales tax unless they have a physical presence in that state.
And online retailing, despite its rapid growth in recent years, still accounted for just 4.6% of total U.S. retail spending as of the third quarter, according to the U.S. Department of Commerce. That means online retail has huge potential to keep taking an ever-larger slice of the consumer spending pie.
As a result, the Web-only retailers have become formidable competition, particularly during the critical holiday shopping season, which is make-or-break for many retailers.
"Web retailers are better-positioned than store retailers," Forrester analyst Sucharita Mulpuru told Bloomberg News. "They in many cases can have better offers because their economics are more favorable."